I have been tweeting about the relationship between asset valuations and GDP and a number of other metrics recently.
My point for some time has been that the relationship between asset valuation and GDP, amongst other reference points, is excessive and out of alignment with slower GDP and income growth. As with many of my other posts the point is this: the financial economy, asset and debt valuations and the complex financial system linking them, has become much bigger and therefore much more important to keep alive. I would go as far as saying that the financialization of the global economy has become too big too fail, an extension no less of the banking dilemma.
Financial risks to economic growth now usurp the usual recessionary risks “we have all come to know and love”. In part this is why the Fed is so concerned over the timing of interest rate rises and why Central Bank’s the world over have cut rates to and below the bone. Along with QE and the ZLB, negative rates have now entered the lexicon of common finance vocabulary.
The above chart shows the continued rise of household and non profit organisation assets to GDP and the blue line total assets divided by corporate profits after tax, which stand at historically high levels as a % of national income. High profit margins and profits growth relative to GDP and income growth is why at certain metrics asset markets do not appear to be excessively over valued.
And also the same chart but with annual average (geometric) nominal GDP growth over rolling 10 year periods:
So on a static GDP measure assets are at historical highs, but GDP growth is also at historically low levels. So the dynamic relationship between assets and GDP growth is even further extended.
So let us look at total assets per capital as a ratio of disposable income per capita: again we see historically high ratios.
Why is the ratio of assets to GDP and income of relevance? If we were to buy an asset the value of that asset would to a large degree be dependent on the future revenue generated from that asset. If economic growth is slowing down at the same time that the price of an asset to GDP is rising we can see a potential for conflict between the value of the asset and its future cash flows. Falling interest rates may well accommodate lower future nominal cash flows and greater risks to future cash flows, but should not necessarily cause asset prices to rise. This has not been the case.
But let us take the analysis yet still further. Let us take the ratio in the above chart and divide it by the the average annual nominal growth in per capita disposable income: we get the blue line in the following chart.
This is effectively a sensitivity analysis that highlights how exposed asset values are to slower income growth and by virtue of this concerns over growth in expected cash flows used to value assets.
And we can also look at household asset growth against the growth in corporate capital expenditure: below is the compound percentage differential between the growth in household and NPO assets and capex.
Even with a lazy shift of the mental gears one should assume that the underlying value of the assets of production should not be materially different from the value of wealth assets, yet the two have drifted materially apart.
And debt levels remain high: US non financial sector credit market debt to GDP has effectively stalled at pre crisis levels :
And the relationship between household debt and wages has deteriorated relative to the wider disposable income metric:
And while household debt as a % of GDP has indeed come down: we can actually see that at current levels it is still historically high. We should not be focussed on the household debt to GDP peak in terms of assessing the relative strength of the financial/economic system with respect to the consumer since peak debt levels represented an unusual period.
We can look at other data sets too that should raise concerns over asset valuations relative to economic growth fundamentals…for example we can see that personal consumption expenditure as a % of disposable income (after deducting current transfer receipts) remains elevated above pre crisis levels.
Indeed there are a myriad of relationships that cast doubt over the value of household assets relative to GDP fundamentals.
Other recent blogs on the subject: